Chapter 23 Textbook Notes
Chapter 23 Textbook Notes Acc 302
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This 4 page Class Notes was uploaded by Lauren95 on Monday April 25, 2016. The Class Notes belongs to Acc 302 at Pace University taught by Reisig in Spring 2016. Since its upload, it has received 28 views. For similar materials see Intermediate Accounting II in Accounting at Pace University.
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Date Created: 04/25/16
Chapter 23- Statement of Cash Flows The primary purpose of the statement of cash flows is to provide information about a company’s cash receipts and cash payments during a period. A secondary objective is to provide cash-basis information about the company’s operating, investing, and financing activities. The statement of cash flows therefore reports cash receipts, cash payments, and net change in cash resulting from a company’s operating, investing, and financing activities during a period. Its format reconciles the beginning and ending cash balances for the period. Usefulness of the Statement: o 1. The entity’s ability to generate future cash ﬂows . A primary objective of ﬁnancial reporting is to provide information with which to predict the amounts, timing, and uncertainty of future cash ﬂows. By examining relationships between items such as sales and net cash ﬂow from operating activities, or net cash ﬂow from operating activities and increases or decreases in cash, it is possible to better predict the future cash ﬂows than is possible using accrual-basis data alone. o 2. The entity’s ability to pay dividends and meet obligations. Simply put, cash is essential. Without adequate cash, a company cannot pay employees, settle debts, pay out dividends, or acquire equipment. A statement of cash ﬂows indicates where the company’s cash comes from and how the company uses its cash. Employees, creditors, stockholders, and customers should be particularly interested in this statement, because it alone shows the ﬂows of cash in a business. o 3. The reasons for the difference between net income and net cash ﬂow from operating activities. The net income number is important: It provides information on the performance of a company from one period to another. But some people are critical of accrual- basis net income because companies must make estimates to arrive at it. Such is not the case with cash. Thus, as the opening story showed, ﬁnancial statement readers can beneﬁt from knowing why a company’s net income and net cash ﬂow from operating activities differ, and can assess for themselves the reliability of the income number. o 4. The cash and noncash investing and ﬁnancing transactions during the period. Besides operating activities, companies undertake investing and ﬁnancing transactions. Investing activities include the purchase and sale of assets other than a company’s products or services. Financing activities include borrowings and repayments of borrowings, investments by owners, and distributions to owners. By examining a company’s investing and ﬁnancing activities, a ﬁnancial statement reader can better understand why assets and liabilities increased or decreased during the period. Classification of Cash Flows o The statement of cash flows classifies cash receipts and cash payments by operating, investing, and financing activities. 1. Operating activities involve the cash effects of transactions that enter into the determination of net income, such as cash receipts from sales of goods and services, and cash payments to suppliers and employees for acquisitions of inventory and expenses. 2. Investing activities generally involve long-term assets and include (a) making and collecting loans, and (b) acquiring and disposing of investments and productive long-lived assets. 3. Financing activities involve liability and stockholders’ equity items and include (a) obtaining cash from creditors and repaying the amounts borrowed, and (b) obtaining capital from owners and providing them with a return on, and a return of, their investment. Note the following general guidelines about the classification of cash flows. o 1. Operating activities involve income statement items. o 2. Investing activities involve cash ﬂows resulting from changes in investments and long-term asset items. o 3. Financing activities involve cash ﬂows resulting from changes in long-term liability and stockholders’ equity items. Format of Statement of Cash Flows Steps in Preparing a Statement of Cash Flows The information to prepare this statement usually comes from three sources: o 1. Comparative balance sheets provide the amount of the changes in assets, liabilities, and equities from the beginning to the end of the period. o 2. Current income statement data help determine the amount of cash provided by or used by operations during the period. o 3. Selected transaction data from the general ledger provide additional detailed information needed to determine how the company provided or used cash during the period. Preparing the statement of cash flows from the data sources above involves three major steps: o Step 1. Determine the change in cash. This procedure is straightforward. A company can easily compute the difference between the beginning and the ending cash balance from examining its comparative balance sheets. The first step is to determine the change in cash. o Step 2. Determine the net cash ﬂow from operating activities. This procedure is complex. It involves analyzing not only the current year’s income statement but also comparative balance sheets as well as selected transaction data. To arrive at net cash flow from operating activities, a company must determine revenues and expenses on a cash basis. It does this by eliminating the effects of income statement transactions that do not result in an increase or decrease in cash. The indirect method (or reconciliation method) starts with net income and con-verts it to net cash flow from operating activities. In other words, the indirect method adjusts net income for items that affected reported net income but did not affect cash. To compute net cash flow from operating activities, a company adds back noncash charges in the income statement to net income and deducts noncash credits. o Step 3. Determine net cash ﬂows from investing and ﬁnancing activities. A company must analyze all other changes in the balance sheet accounts to determine their effects on cash. Sources of Information for the Statement of Cash Flows 1. Comparative balance sheets provide the basic information from which to prepare the report. Additional information obtained from analyses of speciﬁc accounts is also included. 2. An analysis of the Retained Earnings account is necessary. The net increase or decrease in Retained Earnings without any explanation is a meaningless amount in the statement. Without explanation, it might represent the effect of net income, dividends declared, or prior period adjustments. 3. The statement includes all changes that have passed through cash or have resulted in an increase or decrease in cash. 4. Write-downs, amortization charges, and similar “book” entries, such as depreciation of plant assets, represent neither inﬂows nor outﬂows of cash because they have no effect on cash. To the extent that they have entered into the determination of net income, however, the company must add them back to or subtract them from net income, to arrive at net cash provided (used) by operating activities. Significant Non-Cash Transactions 1. Acquisition of assets by assuming liabilities (including capital lease obligations) or by issuing equity securities. 2. Exchanges of nonmonetary assets. 3. Reﬁnancing of long-term debt. 4. Conversion of debt or preferred stock to common stock. 5. Issuance of equity securities to retire debt. A company does not incorporate these noncash items in the statement of cash flows.
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